China official factory activity unexpectedly expands but job losses mount

By Nathaniel Taplin and Pete Sweeney

SHANGHAI (Reuters) - Activity in China's manufacturing activity unexpectedly expanded in March for the first time in nine months, an official survey showed on Friday, adding to hopes that downward pressure on the world's second-largest economy is easing.

But while output rose and new orders from home and abroad returned to growth, factories still shed jobs at a significant rate, highlighting the risks for leaders in Beijing as they try to cut industrial overcapacity without sparking massive layoffs.

The official Purchasing Managers' Index (PMI) rose to 50.2 in March, up from February's 49 but still only marginally above the 50-point mark separating growth from contraction. The findings handily beat expectations for a further contraction.

Economists said a more than one-year blitz of stimulus measures may finally be showing some dividends, particularly steps to revive the ailing property market, with now surging home sales boosting demand for materials from cement to steel.

A government spending spree on infrastructure, while slower to get going, now seems to be having a similar effect.

However, China watchers said more support will still be needed from Beijing and the central bank in the form of higher spending and interest rate cuts as the economy is likely to remain weak.

Indeed, a similar private survey by Caixin and Markit, which focuses on smaller firms, showed manufacturing activity shrank again in March, though at the slowest pace in 13 months.

"The output and new order categories rose above the neutral 50-point level, indicating that the stimulus policies the government has implemented have begun to take hold," noted Caixin chief economist He Fan.

"However, considering current conditions remain uncertain, the government needs to continue with moderate stimulus measures to reinforce market confidence."

The private Caixin/Markit Manufacturing Purchasing Managers' index (PMI) found that output, total new orders and output prices all returned to growth for the first time in well over half a year.

"It does seem to indicate manufacturing is warming up a bit, new orders were...a very strong figure," said Raymond Yeung, senior economist at ANZ in Hong Kong.

"We think there are basically two factors driving the recovery: the first is a possible acceleration in infrastructure spending; the second is a broader pickup in external demand."

Yeung said China's economy could grow 6.5 percent in the first quarter from a year earlier, cooling from 6.8 percent in the fourth quarter but better than many had expected just a month or two ago. First-quarter data is due on April 15.

JOB LOSSES IN FOCUS

Both the official and private factory readings showed manufacturers continued to shed jobs last month, but disagreed on whether on whether layoffs were moderating.

The official survey suggested the rate of job losses may be slowly easing, with the reading at the highest since June, but the Caixin survey showed manufacturers shedding staff for the 29th straight month and at almost the same pace as in February.

Data from the recent China Beige Book quarterly survey showed firms cutting back sharply on hiring and wage hikes, risking a blow to domestic consumption that could hamper any further recovery.

Sources have told Reuters that China is expecting to lay off 5-6 million state workers over the next two to three years as it tries to cut bloated industrial capacity and pollution, though officials say many of those can be retrained for jobs being created in the services sector.

TOUGH TRANSITION FROM "OLD ECONOMY" DRIVERS

Hopes that the long-suffering manufacturing sector may be bottoming out were fuelled by recent data which showed industrial profits rose 4.8 percent in the first two months of 2016 from a year earlier, ending seven months of decline.

China's real estate investment rose 3 percent in the first two months of 2016 in year-on-year terms, quickening from an increase of just 1 percent in all of 2015, though a huge overhang of unsold homes could keep further market gains in check.

Global energy and commodity prices also have staged a limited recovery in recent weeks, which may have bolstered flagging profits at oil and mining firms and reduced strains on their balance sheets.

In addition to the boost from a pick-up in construction activity at home, cash-starved Chinese mills have also been exporting large amounts of steel, which has sparked accusations of dumping from some of its top trading partners.

Finally, some analysts say business confidence may have improved as fears of a sharp depreciation in the value of the yuan currency have eased.

Adding to the cautiously optimistic mood, growth in China's services sector expanded strongly.

The official non-manufacturing Purchasing Managers' Index (PMI) rose to 53.8 in March from the previous month's 52.7.

That is good news for China's leaders as they try to overhaul the economy into one less dependent on exports and rust-belt industries and more driven by domestic consumption.

With manufacturing in a prolonged slump, services have been a crucial source of growth and jobs for China over the past year.

Rating agency S&P cut its outlook for China's sovereign credit rating on Thursday to negative, saying the government's reform agenda is likely to proceed more slowly than expected.

But signs of improvement in the economy, however modest, could give Beijing more breathing room to keep those reforms on track.

(Editing by Kim Coghill)

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